U.S. OverviewSustained Growth: Still Not Enough to Satisfy
In our annual outlook back in December, we made assertions such as “growth in the coming year will remain modest’” and “there is no double-dip or V-shaped recovery” and “every economic recovery is a new normal.” This economic expansion has indeed lived down to our modest expectations. So it was in December and so it is now.
After a gain of 3.0 percent in the fourth quarter of 2011, growth shifted down to 1.7 percent in the first half of this year and is expected to remain in that vicinity for the second half. Positive contributions to growth have come from personal consumption, equipment & software spending, residential construction and structures, but in each case, the gains were more modest than expected. Net exports and federal & local spending are drags on growth. Consumption spending expectations have been lowered as job gains have been weak and real income gains have been limited. The economy continues to grow, but the pace of growth is not enough to satisfy job expectations by households, the profits of investors or the public purse at all levels of government. For decision makers, the challenge remains to find an operational guideline in an economy of modest positive growth with neither boom nor bust.
Inflation, as benchmarked by the FOMC’s target core PCE deflator, should remain below the Fed’s 2.0 percent target rate and thereby keep monetary policy biased toward easing this year. We expect 10-year benchmark Treasury rates to remain in the 1.5 percent-2.0 percent range. Corporate profit growth should remain positive but slow.
International OverviewGlobal Expansion Continues, but It Is Fragile
The global economy has clearly lost momentum this year. The United States continues to expand, but at a subpar pace, and China is registering the slowest growth rates in three years. Many European countries have slipped back into recession.
In response, many central banks have eased policy recently. Under the assumption that Europe does not “blow up,” we project that global GDP will grow about 3 percent this year, not a global recession, but the slowest year since the global downturn in 2009.
Europe Remains the Biggest Risk
Under a worst-case scenario—one in which one or more members of the European Monetary Union abandons the euro—another global financial crisis could ensue. European leaders are caught between the rock of radically restructuring their economic and political systems and the hard place of potential financial crisis and a very painful recession.
In our view, the most likely scenario is one of “muddle through.” We believe that each time the crisis rears its ugly head European leaders will do enough in terms of a policy response to make the crisis die down temporarily. As the record of the past two years shows, however, they likely will not completely “fix it” and tensions in financial markets will ultimately resurface. In this base-case scenario, therefore, the European sovereign debt crisis will continue to wax and wane for the foreseeable future. In other words, we do not see the uncertainty emanating from Europe subsiding anytime soon.